Question

Ellie Mosk, CEO of X-Space Industries, decided to expand the company's product offering beyond the core model rocket business. After investigation, she decided to set up a separate division to design and manufacture products for the drone market. Several companies were interested in having X-Space develop these drones, and financial results, to date, have been encouraging. Revenue was $4 million, gross margins have been running about 40%, and the customer sales and support costs were $1 million. However, there is a growing concern that some customers require a disproportionate share of the sales and support resources, and the true profitability of the customers is unknown. Data were collected to support an analysis of customer profitability: Activity Sales visits Product modifications Phone calls E-mail/electronic communications Cost Driver Sales visit days Number of modifications Number of minutes Number of communications Total Cost $ 486,000 260,000 92,000 162,000 $1,000,000 Customer Visit Days Modifications Revenue $ 400,000 500,000 600,000 1,000,000 1,500,000 $4,000,000 Gross Profit $ 150,000 200,000 230,000 420,000 590,000 $1,590,000 25 40 Phone Minutes 1,030 1,120 1,370 1,720 2,120 7,360 Electronic Communications 625 875 1,000 2,000 2,250 6,750 90 100 Totals 270 200 Required: 1. Management felt the easiest way to allocate the sales and support costs was based on the total revenue. Using total revenue as the allocation base, determine the profitability of each of the five customers. 2. Management felt that because the data revealed some customers require a disproportionate share of sales and support resources, activity-based costing should be used to determine customer profitability. Use ABC to prepare a customer profitability analysis.

Answer 1

Part 1
	Customer	Gross Profit	Share of support cost	Profit after	Profit %
			based on Revenue	support costs	(Expressed as a % of Revenue)
	A	$                                      1,50,000	$                               1,00,000	$                            50,000	12.50%
	B	$                                      2,00,000	$                               1,25,000	$                            75,000	15.00%
	C	$                                      2,30,000	$                               1,50,000	$                            80,000	13.33%
	D	$                                      4,20,000	$                               2,50,000	$                         1,70,000	17.00%
	E	$                                      5,90,000	$                               3,75,000	$                         2,15,000	14.33%
	Totals	$                                    15,90,000	$                             10,00,000	$                         5,90,000
Part 2
	Computation of ABC rate
	Activity	OH Costs(Col 1)	No. of activity base(Col 2)	Activity Rate(Col 1 / Col 2)
	Sales Visits	$                                      4,86,000	270	$                         1,800.00	per visit
	Products Modification	$                                      2,60,000	200	$                         1,300.00	per modification
	Phone Calls	$                                         92,000	7,360	$                              12.50	per minute
	E-Mail/Electronic communication	$                                      1,62,000	6,750	$                              24.00	per communication
	Allocation of Overhead Costs
		Customer A		Customer B		Customer C		Customer D		Customer E
		Activity Based usage	Activity Based usage*ABC rate	Activity Based usage	Activity Based usage*ABC rate	Activity Based usage	Activity Based usage*ABC rate	Activity Based usage	Activity Based usage*ABC rate	Activity Based usage	Activity Based usage*ABC rate
	Sales Visits	15	$                             27,000.00	25	$                              45,000.00	40	$                                 72,000.00	90	$                           1,62,000.00	100	$                          1,80,000.00
	Products Modification	15	$                             19,500.00	15	$                              19,500.00	40	$                                 52,000.00	60	$                              78,000.00	70	$                             91,000.00
	Phone Calls	1030	$                             12,875.00	1120	$                              14,000.00	1370	$                                 17,125.00	1720	$                              21,500.00	2120	$                             26,500.00
	E-Mail/Electronic communication	625	$                             15,000.00	875	$                              21,000.00	1000	$                                 24,000.00	2000	$                              48,000.00	2250	$                             54,000.00
	Total Overhead Cost allocated		$                             74,375.00		$                              99,500.00		$                              1,65,125.00		$                           3,09,500.00		$                          3,51,500.00
	Customer	Gross Profit	ABC Costs	Profit after	Profit %
				support costs	(Expressed as a % of Revenue)
	A	$                                      1,50,000	$                                  74,375	$                            75,625	18.91%
	B	$                                      2,00,000	$                                  99,500	$                         1,00,500	20.10%
	C	$                                      2,30,000	$                               1,65,125	$                            64,875	10.81%
	D	$                                      4,20,000	$                               3,09,500	$                         1,10,500	11.05%
	E	$                                      5,90,000	$                               3,51,500	$                         2,38,500	15.90%
	Totals	$                                    15,90,000	$                             10,00,000	$                         5,90,000